December 23, 2009 – Contrary to common belief, hyperinflation does not arise from too much bank lending. The sole cause of hyperinflation is always too much government spending. The pattern is as follows.

The government spends more money than it is receiving in taxes, which forces it to borrow. As these deficits grow, they eventually exceed the market’s capacity or willingness to lend money to the government. Invariably, the central bank steps in and provides the government with the money it needs by creating it – as the saying goes – ‘out of thin air’, or what governments today call “quantitative easing”. The central bank does this in either of two ways.

In cash currency economies, where most commerce is completed by making payments with paper-currency, the central bank cranks up the printing press. Examples are the Weimar Germany hyperinflation in the early 1920s, and just recently, Zimbabwe.

In deposit-currency economies, where most commerce is conducted by making payments through the banking system with checks, wire transfers, plastic cards, and the like, the central bank uses electronic bookkeeping made possible through computers to put the newly created money directly into the government’s checking account. There are numerous examples of deposit-currency hyperinflation in the monetary history of Latin America, like the one that devastated Argentina in 1991.

These two different ways in which hyperinflation manifests itself are made clear in the following quote by Ben Bernanke before he was appointed chairman of the Federal Reserve: “The U.S. government has a technology, called a printing press (or today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at no cost.”

There is of course a cost. There may not be one to the US government, but instead, the cost will be borne by everyone who holds dollars and loses purchasing power as a result of Mr. Bernanke creating as many dollars as the government wants to spend. The other word for this cost is inflation.

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